LONDON - Regulators will have powers for the first time to punish banks in the European Union whose pay policies encourage too much risk-taking, under a draft law published by the bloc's executive body on Monday.

The European Commission proposals tighten EU rules on bank capital requirements to apply lessons from the worst financial crisis since the 1930s, and requires banks to improve disclosure of the holdings in securitised products -- the type of assets at the heart of the credit crunch.

The rules, coupled with other anticipated reforms, will make it harder for banks to earn high returns on their assets.
The draft EU rules are due to come into force in 2011 as part of wider efforts to restore investor confidence but because they will dampen a bank's ability to lend and thus aid economic recovery, timing could change.

If we think it needs to be delayed further, that could be done if we think they could have a detrimental effect on the general economy, Ruth Walters, an official at the Commission's internal market unit, told reporters.

The draft, which requires adoption by the European Parliament and EU governments to become law, also proposes to double capital requirements on risky assets held by banks on their trading books, the Commission said in a statement.

There will also be far higher capital requirements for re-securitisations to reflect better the risks they contain, a step the Commission said could limit recovery of the secondary market in these products.

Greater disclosure requirements will cost the EU banking industry 1.3 million euros a year, the Commission added.

The hope is that if conditions suddenly turn sour or credit dries up like in the financial crisis, banks have enough buffers to absorb losses and avoid firesales of assets which depress prices further.

The G20 group of industrialised and emerging market countries agreed in April that banks must have higher capital buffers once economic recovery is assured.

Hiking capital charges and improving supervision is core to efforts by policymakers globally to plug regulatory gaps highlighted by the credit crunch that saw undercapitalised banks having to be bailed out by taxpayer money.

The draft's elements on capital puts into EU law reforms already underway of the Basel II rules, a globally-agreed framework for capital rules drawn up by the Basel Committee on Banking Supervision.
The actual levels of higher capital charges on banks under the EU law may hinge on work being done by the Basel Committee.

The G20 also agreed that supervisors should have powers to oversee remuneration based on principles put forward by the Financial Stabilty Board, a new watchdog that will police consistency in financial rules across the globe.

The draft law will focus on pay policies for top officials, including severance pay, whose work affects the bank's risk profile, ensuring there is an appropriate balance between fixed and variable pay.

It is true that employment contracts are likely to be renegotiated and that the fixed component awarded could be higher, the Commission said.

Supervisors won't determine actual levels of pay.

The European Banking Federation said the draft law contained no surprises and that banks were prepared for changes.

What we don't want is supervisory authorities to determine the level or form of remuneration, an EBF spokeswoman said.

We also insist that the new rules in terms of remuneration are international. We want a level playing field, the spokeswoman said.

The EU adopted an initial reform of its capital requirements rules in April to beef up supervision of banks and make securitisation markets safer.

A third wave of reform will be proposed in the autumn and is expected to include proposals to toughen up liquidity requirements and introduce a simple cap on leverage.

(Reporting by Huw Jones; Editing by Dale Hudson and Patrick Graham; Editing by Victoria Main)